The shining promise of ethanol doesn’t add up for farmers

No one can begrudge corn farmers their share of euphoria over the recent ethanol boom.

Until very recently, their plight could be summed up by a bit of gallows humor I once heard from a dairy farmer: “I lose money on every gallon, so I try to make up for it on volume.”

Hopes are rising along with corn prices.

That brief sentence sums up the desperation of large-scale farming. When prices drop, the farmer hopes to compensate by producing more. But everyone else has the same idea, so the price just drops further.

For most of the last three decades, the price of commodity corn has hovered at about $2 per bushel (which is 56 pounds). That means corn fetched for its growers a mind-numbing 3.5 pennies per pound — less than the cost of production, which has risen steadily over the decades. Meanwhile, corn buyers — chiefly Archer Daniels Midland — reeled in fat profits by turning all that cheap corn into high-fructose corn syrup, ethanol, and feed for confined-animal feeding operations.

ADM kept the whole system lurching along by leaning on Corn Belt politicians to push through Farm Bills that would pay farmers just enough to keep over-producing despite fire-sale prices. According to the Environmental Working Group, corn farmers received a stunning $41.9 billion in federal subsidies between 1995 and 2004 — more than wheat and cotton farmers combined. (For the 2006 crop, the USDA recently announced, corn farmers will be handed $3 billion.) It’s important to understand, though, that ADM shareholders, not farmers, benefited most from this expensive arrangement.

For ADM, the government handouts mean a steady supply of cheap corn, and thus low production costs. For most farmers, the government check has just meant that the combine note can be paid, that next year’s seeds, pesticides, and fertilizer can be bought, and so on.

Now, however, the ethanol boom is changing things. For one, surging ethanol demand has spurred a rally in corn prices. Even as the Corn Belt’s farms churn out as much product as they possibly can — the 2006 harvest is projected to be the second-largest on record — corn is trading for more than $3 per bushel on the Chicago futures markets. That’s the highest level since a brief bullish run in 1996. For the first time since then, corn farmers are actually earning a small profit in the marketplace.

More significantly, many corn growers are no longer satisfied selling their product to ADM and watching that company spin it into gold. Instead, they’re pooling their money, forming partnerships, and investing in their own ethanol plants.

Planting the Seeds

For these farmer/investors, ethanol plants promise a can’t-lose scenario. Producing ethanol theoretically provides a hedge against low corn prices, because when corn prices dip, ethanol production becomes more profitable. And if ethanol demand keeps surging, it will suck in more corn, meaning rising prices for the farmers’ main commodity.

Yet I fear these hopes will prove to be hollow.

Most environmentalists agree that the “green” case for corn-based ethanol is a sham: Even if the fuel’s energy balance is marginally positive, that factor is probably outweighed by the vast environmental liabilities of large-scale corn production.

From the farmer cooperative’s perspective, the economics of corn-based ethanol may be even worse.

Ethanol owes its current boom directly to two government actions in the 2005 Energy Policy Act. For one, the act ordered the phaseout of MTBE, a gasoline additive known to pollute groundwater, by 2014. Oil refiners reacted rapidly, turning to ethanol as a gasoline additive to meet oxygenate standards that could no longer be met by MTBE. Secondly, the act mandated that the gasoline industry use at least 7.5 billion gallons of “renewable” fuels by 2015, up from about 4 billion gallons in 2005.

On top of those boosts, the act renewed the 51-cent-per-gallon tax break refiners get for mixing ethanol into gasoline, and maintained a 54-cent-per-gallon protective tariff against imported ethanol.

As a result, the ethanol industry has entered a gold-rush phase. As refiners scrambled to replace MTBE with ethanol in their gasoline mixes, ethanol prices spiked. For a time, Archer Daniels Midland — by far the largest ethanol producer with 30 percent market share — was netting a dollar in profit for every gallon of ethanol it produced. Given that ADM produces a billion gallons per year, with plants under construction to add another half-billion gallons of annual capacity, that’s not bad.

It’s no wonder, then, that farmers are scrambling to open cooperatives and line up financing from banks and Wall Street to build new plants. After decades of losing money on every bushel of corn, what farmer wouldn’t want to make a buck per gallon on fuel?

The trouble is, while demand for ethanol still outstrips supply, that situation probably won’t last.

What Goes Up Must Calm Down

As more distillers enter the market, ethanol’s price — and profit margin — will fall. According to a recent Dow Jones article, there are now 102 operational ethanol plants, 32 under construction, and another 127 in various stages of planning.

If all of those proposed plants come online, Dow Jones reckons, the industry will soon be churning out 16 billion gallons of ethanol per year — about four times the 2005 level. To do so, they’ll eat up 5.3 billion to 5.9 billion bushels of corn. In 2005, ethanol took just 1.6 billion bushels.

That surge in usage will likely mean a big jump in the price of corn. And here’s the catch: if the corn price surges, it will make ethanol production much less profitable. This will force farmer-owned cooperatives to charge more for their product. And if ethanol is much more expensive than petroleum-based gasoline, it’s unlikely the market will have much use for 16 billion gallons of ethanol per year. Remember, federal law requires refiners to use just 7.5 billion gallons annually of “renewable” fuel by 2015. It seems doubtful that the market can absorb twice that much over the next few years.

What we’re looking at is the dirtiest four-letter word in the energy lexicon: glut. Which players in the market are the likeliest to fail if ethanol prices dip below the cost of production? Small fry like farmer-owned cooperatives. And what deep-pocketed player is likely to ride out the storm, then snap up a bunch of failed ethanol plants for pennies on the dollar? Well, that would likely be the biggest producer of all: Archer Daniels Midland. And what happens when ethanol production falls after a bunch of plants shut down? The price of corn drops, and farmers are right back where they started.

I can fully understand why the Midwest’s beleaguered corn farmers are seeking more control over their financial lives by forming partnerships. But rather than pursue the environmentally and economically suspect ethanol dream, I have an idea that might sound crazy at first: Stop producing mass quantities of industrial inputs like genetically modified field corn, and start producing food for neighbors to eat.

In my next column, I’ll show how such a mad scheme could actually work.